The Market Today
Fed Will Wait and See After Latest Rate Cut; Monitoring Funding Markets but Sticking with Temporary Fix for Now
by Craig Dismuke, Dudley Carter
Initial Jobless Claims Reinforced Labor Market Stability: Initial jobless claims rose less than expected last week, from a revised-higher 206k to 208k. After two low reading to start September, the four-week average has fallen back to 212.3k, one of its lowest readings since 1969. While indications show hiring has slowed in recent months, the claims data has consistently shown the labor market is holding up under the pressure of increased economic uncertainty.
Philadelphia Fed Outlook Softened Less Than Expected: The Philadelphia Fed’s Business Outlook index fell less than expected in September, holding near the middle of a volatile 2019 range but below much stronger levels from 2017 and late 2018. The forward-looking index also weakened, as softer expectations for new orders and shipments offset a better outlook for hiring.
Fed’s Third Temporary Open Market Operation This Week: In its third intervention in the overnight funding markets, the Fed’s received securities collateral for $75B in overnight funds through its repurchase for a facility. For a second day in a row, the offer was oversubscribed, this time by $8.9B.
Later Today: At 9 a.m. CT the Conference Board will release the Leading Index for August (expected -0.1%) and the National Association of Realtors will announced existing home sales results for August (expected -0.7%).
OVERNIGHT TRADING ACTIVITY
Mixed And Muted Response To Major Central Bank Decisions: Global markets have shown a mixed response to yesterday’s Fed cuts and decisions from a couple of other major central banks on Thursday. Stocks were mixed across Asia but firmer in Europe, while U.S. futures had weakened slightly just before 7 a.m. CT. Sovereign yields were lower in the U.K. following the Bank of England’s decision but higher across mainland Europe. Treasury yields had ticked lower, reversing a portion of yesterday’s post-Fed sell-off. The Dollar had erased nearly all of yesterday’s gains and oil prices rose to unwind yesterday’s decline, leaving U.S. WTI up nearly 8% for the week.
Bank Of Japan Hints At Upcoming Ease: After the Fed’s divided decision to cut rates yesterday, central banks in Japan and England elected to hold policy steady for now. The Bank of Japan noted that because “downside risks seem to be increasing, …it is becoming necessary to pay closer attention to the possibility the momentum toward achieving the [2% inflation] target will be lost.” In his press conference, Governor Kuroda said, “If it’s a question of whether I’m more inclined to go ahead with easing than at the last meeting, yes, that’s right.” The Bank of England acknowledged heightened global risks as well, including a no-deal Brexit, and said that these risks “could lead to a further period of entrenched uncertainty.” They noted, “The longer those uncertainties persist,” the greater the risk that the economy slows and inflation pressures decline.
YESTERDAY’S TRADING ACTIVITY
Markets Set Up Dovishly Ahead of The Fed: After a relatively-quiet overnight session, yields gradually grinded lower during the morning in an apparent dovish setup ahead of the Fed’s afternoon decision. Just before the announcement, the Treasury curve was near its lows of the day with the 2-year yield down 5.9 bps and the 10-year yield 5.4 bps lower. However, other markets reflected a bit of uncertainty around those dovish expectations. The S&P 500 had traded down 0.3% and the Dollar was holding up around unchanged. However, when the headlines were unembargoed and pushed to traders’ Bloomberg terminals, those moves quickly reversed.
Data-Dependent Fed Kept Optionality: In response to a Statement and set of economic projections that were little changed, and a dot plot that showed the median official expects no additional rate cuts from here, Treasury yields pushed off their lows, the stock market sold off, and the Dollar shot higher. At 1:30 p.m. CT, Fed Chair Powell hosted what may have been his cleanest and most crisp press conference yet. He clearly and consistently stated that the Fed is optimistic about the outlook but aware of the risks. He also stressed that Fed policy is not on a preset course but ready to respond aggressively if the data warrants.
Rates Rose After Fed Showed They’re Watching But Don’t’ Expect Another Cut: Combining Powell’s balanced tone with the sanguine materials that tilted more hawkishly than markets expected, Treasury yields and the Dollar held their increases. On the back of a reversal upward in bank stocks, the S&P 500 managed to edge back into positive territory. The 2-year yield ended 3.7 bps higher at 1.76% after sliding as many as 6.5 bps before the decision. Fed funds futures ended the day little changed on net. The 10-year yield closed down 0.5 bps at 1.80% after dropping as many as 6.0 bps earlier. The S&P 500 erased a 0.6% gain to close nearly unchanged as bank stocks climbed into the second place spot.
Fed Materials Reinforce Fed’s Monitoring Stance, With No Sign Of A Policy Lean: The FOMC voted 7-3 in favor of cutting its overnight target range 25 basis points to 1.75-2.00% because of the “implications of global developments for the economic outlook as well as muted inflation pressures.” Among the dissenters, President Bullard preferred a 50 basis points cut while Presidents Rosengren and George preferred no policy change. In a likely response to the recent move of the effective Fed Funds rate outside of the target range, the Committee lowered the interest on excess reserve rate and the rate on overnight reverse report by 30 basis points each, to 1.80% and 1.70%, respectively. The divergence between the solid consumer but weaker business and export activity was pointed out in the Statement which was otherwise hardly changed. Retaining their future optionality, the Statement continued to note that they “will act as appropriate to sustain the expansion.”
Outlook Little Changed, Dot Plot Lowered To Reflect Recent Cuts But Nothing Further: The updated economic projections saw notably minor tweaks while the rate projections in the dot plot were revised lower across the board. However, the more shallow path was necessarily caused by the July and September rate adjustments which hadn’t been reflected in June’s median expectations. While seven officials expect another rate cut this year, ten others disagreed, keeping the median projection for no additional rate cuts in 2019. The rate is also expected to remain unchanged throughout 2020, based on the median estimate, before gradually drifting higher in 2021 (2.125% midpoint) and 2022 (2.375% midpoint) toward the longer-run estimate of 2.50%.
Powell Kept His Balance: In his post-meeting press conference, Chair Powell walked a more narrow path than his previous meetings, often reading from what appeared to be scripted answers. Wednesday’s rate adjustment was “insurance against ongoing risks,” he said, and policy is not on a “preset course.” The committee will assess its next steeps “meeting by meeting.” He struck a balance when asked if he saw this cut as a “mid-cycle adjustment,” saying “We see a favorable economic outlook, …though, there are risks to this positive outlook due particularly to weak global growth and trade developments, and if the economy does turn down, then a more extensive sequence of rate cuts could be appropriate.”
Fed Will Stick With Temporary OMO Until They Learn More: However, more interesting were his comments on the recent pressures in overnight funding markets and possible implications for the Fed’s balance sheet policy. “While these issues are important for market functioning and market participants,” Powell said, “they have no implications for the economy or stance for monetary policy.” For now the Fed will use temporary open market operations as needed to keep overnight markets functioning smoothly, but “it is certainly possible” that they will need to stop the reserve run-off “earlier than we thought.” He added, “I think we’ll learn quite a lot in the next six weeks,” about the potential need for a more permanent solution or necessary adjustments to the level of reserves currently in the system.